Apparently I am not the only one who believes quantitative easing is a “non-event”. In a recent note UniCredit analysts describe why they believe the Fed is out of bullets and will have little to no impact on markets with its “creative” new forms of monetary policy:
“There are, however, two factors that suggest the yield effect will be smaller than calculated. When the US central bank began with the first round of the quantitative/credit easing in autumn 2008, the financial markets were still in panic mode. In the wake of the collapse of Lehman Brothers and the escalating economic crisis, a complete collapse of the financial markets even appeared to be a distinct possibility. The risk premiums for all asset classes were correspondingly high at the time – also for Treasuries. Thanks to its resolute intervention, the Fed was able to restore a certain degree of basic confidence on the market. The probability of a collapse was averted, and the risk premium fell dramatically. Today, in contrast, the risk premium is already very low. The possible yield effect of additional quantitative easing would, therefore,come exclusively via the higher demand for Treasuries (portfolio balance effect). The second factor that suggests yields would fell less strongly than suggested by the NY Fed model is the law of diminishing returns: The more Treasury securities the US central bank already holds, the lower the effect of further purchases becomes. Net for net, we therefore assume that even a massive additional program for the purchase of Treasury securities totaling one trillion USD would lower the yield level by only approximately 25 basis points.”
UniCredit correctly argues that lower rates are unlikely to fix the system because the lending markets are effectively clogged:
“Lower interest rates stimulate the economy via different transmission channels. Some of these channels are, however, clogged, thereby reducing the impulse of a more expansive monetary policy on the economy as a whole. A study conducted by the Federal Reserve Bank of San Francisco shows that lower interest rates influence the real economy primarily through four channels: (i) the cost of borrowing, (ii) the supply of credit, (iii) household wealth and (iv) the exchange rate.
Because of the after-shocks of the housing market crisis, households are profiting only to a limited extent from lower capital market rates.
The reason for the reluctance of businesses to invest is the uncertainty concerning the economy and regulatory aspects. Not even lower interest rates can change this.”
UniCredit believes this is a major “paradigm shift” in the way markets view monetary policy. In essence, the Fed is impotent and the markets are only just beginning to realize this:
“Are we possibly now experiencing a “paradigm shift”, in which the monetary policy possibilities of the Fed are, in principle, being assessed more negatively? Under the aegis of former Fed Chairman Alan Greenspan and also under his successor Ben Bernanke, the term “Greenspan put“ has become established to describe the “psychological impact” of the way the Fed reacts to economic downswings and crises. It describesthe basic assessment of investors that the Fed will rapidly counter-steer with monetary policy in the event of economic downswings or crises and thereby limit the downside risk for risky assets – first and foremost equities. The presumed Greenspan put was practiced successfully for example after the October 1987 crash as well as after the LTCM and Asian crisis. The widespread view is that this increases the willingness of investors to assume risk and tends to lower the demanded risk premium of equity investments. Must investors now again arrive at a more negative assessment with respect to the future possibilities of the Fed? When it comes to the performance of the equity market on rate cuts, there were in recent years already interesting changes that favor a rethink.”
Of course, I entirely agree with the above analysis and it’s nice to see a large firm finally issuing a note that accepts the fact that this is a non-event as opposed to the constant misguided fear mongering about “money printing” and “monetization” that we hear from all other camps. The bottom line according to UniCredit – The Fed is becoming powerless and that could become very disconcerting to the equity markets:
“Bottom line: There are, in our view, plausible arguments supporting skepticism towards the economic efficacy of any further easing of US monetary policy. There is, therefore, the risk that going forward investors will be much more pessimistic in their assessment of the Fed’s ability to counter-steer using its monetary policy in the event of an economic slowdown. This would be tantamount to a paradigm shift from the “Greenspan put” to the “powerlessness” of the US central bank – with negative ramifications for the equity markets in the USA and Europe.”
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.